Wow, that’s a lot of iPhones.

TEN SQUILLION GODZILLION iPHONES. That’s how many they are making in the 3rd quarter alone. I only mention this to try to make myself look a bit better after having hung my dirty underpants out to dry this week, for I, Baruch, predicted just this! I am not a complete investment dolt! OK I didn’t give numbers, but I said, in a piece which was long term negative on Apple but short term positive (know, and do not confuse, your time frames):

Apple . . . has a window to build some scale. At the same price as an HTC, hell, I’d buy a 3G iPhone. I can finally see it taking off

and

this is what I imagine will happen: a flattish reception to the 3G iPhone launch in May or June (I hear it looks identical to iPhone v.1, and may not have GPS or a 5 megapixel camera), followed by amazing initial volumes of 3G iPhone.

There was a flattish reception; AAPL sold off a bit after a rally into the launch announcement and everyone seemed more interested in whether Steve Jobs had cooties or not. I hope he doesn’t. “MobileMe” didn’t work (one wag said the Blackberry version of this would be called “RimmMe”). But this 10 million number has blown my mind. “Amazing initial volumes” is an understatement. For context, there will be about 1.1-1.2 billion cellphones sold in 2008, according to like, everybody. So 10 million sounds like small beer. But that’s in one quarter, so really it’s 40 million annualised, which is 3.5% unit share from zilcho (iPhone v.1 was negligible), and then assuming a $550 average selling price — pre-subsidy of course — and a $120 ASP for the rest of the market, and assuming they actually sell them in Q3, well Apple just took a 16% share of the total value of the handset market, give or take. In other words, it just created the equivalent of RIMM’s handset business, Sony Ericsson, the equivalent of LG handsets. In one quarter. Just like that!

There just isn’t room in the market for that type of share loss. There are good reasons to believe growth in the overall handset market is slowing. I don’t know who is going to lose that 16%. I suspect everyone will lose a bit. RIM will see its growth slow (not good news at 35x PE), Nokia high end will suffer. Sony Ericsson and Motorola really, really don’t need this type of aggravation. Somehow I suspect Samsung will be OK. LG? Palm? HTC? Until these guys have something to fight iPhone, the only way to compete will be pricing inferior product to a point where it can compete.

Of course, this is the first quarter of build, where Apple are launching the phone in 80 countries or something and have to stock the shelves. Smarter people than me call this “initial channel fill,” and question whether it is sustainable. It could just be the fanboys buying it (though I plan to get one too). Whether it is or not there is no question, however, that this quarter is going to be a bit of a stinker for everyone involved in the handset market, from vendor to component maker to operator who isn’t Apple or also designed into the iPhone or selling the iPhone.

As for my thesis, step one complete. You will remember the thesis: I was negative on Apple, long term, because they are taking a major gamble on iPhone from a position of weakness, a stalling iPod franchise; after a big initial splash, they will find it difficult to build scale and make the same margins off the iPhone, and in the worst case it could be a major albatross around their necks.

This is still in play. A major shock for Apple’s competitors, and awful quarters in Q3 and maybe Q4 will make clear that fighting the iPhone successfully means a huge effort in terms of R&D and time to market, and Nokia, RIMM, Samsung et al will have to throw whatever they can at the project. They’ll probably come up with something. Opex intensity is set to rise in the space, bad news for everyone, and remember, Apple hamstrung themselves by exclusive agreements with single operators in Europe. But right now the competitors are distracted, overly sanguine, and the instant scale and momentum Apple seems to have created is truly impressive. If they can continue, I may have to revisit my conclusion.

Right now I could think about a trade like long Apple, longer the people who make the bits (except Qualcomm, who have no bits in the iPhone, and whose customers are going to lose share), and short everything else in handsets (note to readership: do not follow stock tips from pseudonymous bloggers). I would think again about this positioning when we are in Q1 next year. I would have said November would be the time frame for the trade to get stale, but we have some sense of the product pipelines for the competitors, and they seem to suck. Again, the only weapon they have here is price.

That might mean revisiting my conclusion, but not in a good way: what if Apple’s entering the smartphone market turns out to be a disaster for everyone? What if it leads to huge price down, greater competition, and an overall lower margin in the market? Not just long term Schmapple, but Schmokia, Schmimm and Schmamschmung too? Say what you like about Baruch, but know that he refuses to persist in error!

I just thought “higher capex intensity” sounds better, and is quicker to say, than “spending more on research and product development, at the same time as increasing marketing spend, with the net result that ceteris paribus, industry operating margins will necessarily be affected.”

“[I]n the worst case it could be a major albatross around their necks.”

Really? An albatross?

Ah wel-a-day! what evil looks
Had I from old and young;
Instead of the Cross the iPhone
About my neck was hung.

But seriously, you say you might consider being long Apple, but longer the “people who make the bits”. I wonder if the opposite makes more sense.

Apple appears to be moving more of the high-end iPod/iPhone silicon design in-house (witness the recent purchase of PA Semi). As time goes by profit margins on the “bits” not designed by Apple, the easier stuff, will likely fall, because all the really valuable IP will increasingly be owned by Apple.

Plus, since Apple controls the overall design, the “people who make the bits” are at Apple’s mercy. Just last year, Wolfson got cut entirely from the next-gen iPods, and the stock tanked.

Yes Doctor, you may be right about the long term evolution to in house silicon etc, but the “bits” i was thinking about were the baseband and maybe the touchscreen — you don’t see AAPL coming up with a proprietary HSPA baseband anytime soon, do you? or becoming a panel maker.

Also I may have a shorter timeframe here, 3-6 months.

Your warning re Wolfson is well noted though. I remember when AAPL screwed Synaptics on iPod interface, designed them out completely, I remember, which blew up the stock completely. It hurt a lot, we were long.

Hmm, Smapple, Shmokia, Shimm…sounds yummy, bring it on. As a consumer, I quite enjoy the concept of all players in an industry bleeding red…it’s like an open bar for all of us! In the brief periods when Canada has a 3rd airline (before it goes broke…and it always goes broke), flying is cheap cheap cheap. Maybe the same will happen with handsets. However, given that I make a living in the wireless industry, maybe that’s not so great.

Dr.No, I don’t really think there’s any high end chip IP in the iPhone. The teardown reveals all the expected standard chips: GPS receiver, various wireless modems, a processor, some RAM, etc. What struck me was the fact that we’re not that far away from every single piece of digital silicon in an iPhone being integrated onto a single system on a chip (SOC) with an associated plunge in BOM costs. The real valuable IP is in the industrial design, OS, UI and application platform (and their overall integration). The chip stuff is commodity and interchangeable.

BTW, I went out and got the 3G iPhone (I had Rogers courier it to me…waiting in line for a phone seems a bit lame). And my reaction after having it in hand for 3 weeks…WOW. Beautifully usable. I find myself using it as my primary casual e-mail and web surfing device, even when sitting on my sofa with my laptop 3 feet away. Anyone who does a feature list comparison with other smartphones (e.g. the crappy camera and lack of video capabilities, which does suck) is missing the point entirely (and probably has never used an iPhone). It really does enable the mobile web. As far as apps go, I’ve downloaded a few and paid for one (a $1 unit converter). Some people complain about the lack of killer aps but for chrissake, it’s an actual app platform. They’ll come along. I’ve always mocked Apple fanboys and then the bastards put this thing in my hands. Fake Steve Jobs must be laughing his ass off.

I’ve never owned a smartphone before this. I tried a Nokia N95 and gave up after about 5 minutes of trying the check my e-mail (the main issue was text entry for passwords). Apple has set a high bar with the iPhone which the lookalikes will have a tough time matching. After all, is there anything more generic than a music player yet look at the iPod’s market share. Now apply that to phones. I wouldn’t put 20% market share out of reach, especially if they come out with different models with feature and pricepoint variants.

Yes, I too hate all things Apple, but sadly I have to get one. I tried messing about with one a colleague had bought and it was great, the typing was even as easy as on my HTC. But the browser, ah, what can i say.

I have no such hopes for the Samsung Tocco, or the Nokia Tube, tried surfing on a RIMM Curve, and an HTC Touch with Opera browser and it was rubbish.

My views. I have little idea. Sounds bad, but I suspect that unless it is something fundamental with the chipset (I hope not, I own some Infineon), it should be fixed. It may also be the networks, most 3G NWs carrying iPhone in Europe are quite “thin” for data. Also, no-one I know has any real experience on browsing with 3G on a handset. Expectations are low.

I might wait a bit for it to be fixed before I get one, however.

Anyway, I did history at university. I still get confused with the difference between bits and bytes. Ramster would be more your man for this. Ask him.

This is a pretty tough nut to crack. The observed end user performance is a witch’s brew of people’s subjective assessments, the device’s radio performance and the coverage of the operators’ 3G networks. In addition, the operators haven’t really set any expectations of what kind of data rates people should expect to see (other than 3G is faster than EDGE). We also don’t know exactly how the operators are configuring their 3G. Depending on how you set up your 3G base-station, the maximum speed can vary by a factor of 10.

Firstly, there are reports of degraded receiver performance. In particular, there’s a reference to the the “nominal sensitivity is several decibels below what it should be”. The sensitivity is a measurement of the minimum received signal level at which the device can operate at a given data rate. The lower, the better. If the sensitivity is in fact below par, each 3G base-station would end up covering less area than the operator expected, though the operator should catch this in the field testing that is typically done after each base-station is deployed prior to offering commercial service. A 2 dB degradation in the sensitivity would reduce the area covered by a base-station by about 25% (that’s very approximate). This could lead to user performance degradation but as I said, this should get caught in field testing after the network is initially deployed.

The second possibility is that the operators just cheaped out on their 3G deployment and didn’t put out as many base-stations as they should have for good coverage. This strikes me as pretty likely. With cellular networks, you can spend $X to cover a city with 90% reliability (i.e. target performance will be achieved in 90% of the area). Or you can spend $2X to get 95% reliability. Why not just spend $X and let people fall back to EDGE when they’re in the 10% of the city that’s not getting 3G coverage. It’s a good way to keep your CAPEX low initially. Eventually you’ll roll out additional base-stations to get 95 or even 99% coverage but it’s not worth it to do so right away.

So maybe there is a performance degradation in the radio. I would caution that receiver sensitivity is a notoriously difficult test to conduct accurately in the lab. It requires very good RF knowledge, extremely expensive equipment and rigorous experimental methodology. It’s incredibly easy to make an error of a few dB. I generally don’t trust anyone’s result unless I have a good sense of their lab setup so I’d take any report with a serious grain of salt.

Overall, the observed problems are probably a mix of all the mooted causes. Any actual hardware defect is likely to be marginal (i.e. a few dB). Anything more egregious than that almost certainly would have been caught in Foxconn’s manufacturing test process. My guess is that things will get better as the carriers improve their coverage over time. Of course, a growing subscriber base will increase congestion so the end user experience may not actually get any better. Isn’t wireless fun!